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Bankruptcy plan would saddle system with more risky debt, water board analysis says

JeffCo Plan 2.JPG

One of these things is not like the others. Jefferson County's proposed debt service escalates like a ballooning mortgage, unlike all other similar sewer and water utilities. (Source: Porter White & Co.)

If you look at the county's past debt service on the sewer system, they all have had this pattern.

BIRMINGHAM, Alabama -- When compared to the debt structures of comparable water and
sewer utilities, Jefferson County's proposed bankruptcy plan could be best
described in terms of a children's game.

One of these things is not like the others.

In preparation for a bankruptcy court hearing last week, the
Birmingham Water Works Board hired Porter White & Co. to analyze Jefferson
County's proposed plan for exiting bankruptcy, including the county's schedule
of rate increases and debt service.

That analysis gives a brutal assessment of Jefferson
County's plan for exiting bankruptcy. It shows how the county's proposed debt
service schedule escalates over the 40-year course of the debt, much like a
ballooning mortgage - and completely different than the level debt service used
by all similar water and sewer utilities the firm examined.

The analysis also
shows how far afield the county's proposed post-bankruptcy debt is from what at
least one ratings agency considers a safe investment in public utility
bonds.

In addition, water board staff members were prepared to show
how Jefferson County sewer customers are having service cut off for lack of
payment at a rate that exceeds those who are not on the system, the water
system's chief financial officer told the board Friday.

The sample of systems examined by Porter White & Co.
included other water and sewer systems that have entered into federal consent
decrees with the Environmental Protection Agency, including Atlanta,
Louisville, Kansas City and Memphis.

Every sewer and water utility examined by the study had debt
service that remained flat or declined over time, much like a fixed rate
mortgage on a home.

Under the plan proposed by the county, debt service payments
for the first 10 years of the 40 year plan would remain below $100 million per
year. After that, though, the county's debt service begins to climb sharply
until reaching more than $275 million per year.

"So they would not run into trouble for the next 10 years,
but after that it takes off precipitously," White told the board Friday. "If
you look at the county's past debt service on the sewer system, they all have
had this pattern."

In an interview last week, White said that his firm had
looked hard for another example of a sewer or water utility that used
escalating debt service, but they could not find one, including among systems
the county had compared itself to in its own reports.

"If I had found just one, it would make me feel better about
our chart," he said. "But if there's one out there, we haven't found it."

On Friday, White told the board that his firm had quit
charging for its services when the judge ruled it did not have standing to
challenge the county's bankruptcy plan, but he said the firm would continue to
examine every utility debt structure it could find in public records.

"I am trying to do the same thing with all of them, so that
no one can accuse us of cherry-picking," he said.

At the same time the county's annual debt service increases,
it underfunds capital costs to a projected total of $1.2 billion over the life
of the debt.

White and other water works officials said that projecting
capital expenses beyond five or 10 years is not typical among utilities because
those costs are so difficult to predict.

But even if those projections are accurate, the county's
growing debt burden would likely prohibit it from borrowing more money to pay
for upkeep of the system after 10 years. Instead, those costs would have to
come from either even higher sewer rates or other sources of revenue, such as a
new tax.

The county's debt structure might look like a ballooning
mortgage, but unlike on a mortgage on a home, the county would not be able to
refinance later to extend principal payments or take advantage of lower
interest rates. So-called "make-whole" provisions in the type of warrants the
county proposes to use, called "capital appreciation warrants," would negate
the ability of any future bond deals to reap savings.

Rating agency
standards

When the county reached a tentative agreement with its
largest creditors on a plan to emerge from bankruptcy earlier this year,
commissioners bragged that the plan would greatly reduce the principal debt it
owed to Wall Street.

However, the county will have to refinance the remaining
debt that hasn't been conceded by Wall Street at much higher interest rates.
When you add the principal and interest the county proposes to pay together,
the county will have to pay about $650 million more than it would have had its
previous debt structure not fallen apart.

"When the county says that it has reduced debt by 1.2
billion or more, it is ignoring the fact that it is incurring interest
obligations that bring the total burden back to the same place that it was,"
White said.

In July, Fitch Ratings, one of several Wall Street ratings
agencies, released a report on criteria for evaluating water and sewer bonds.

Those criteria evaluate the strength of those utility bonds
by, among other factors, the amount of debt per customer a sewer or water
system has.

According to Fitch, a sewer system with less than $1,500 of
debt per customer would be a strong system and a safe investment. A sewer
system with $2,100 of debt per customer would be a weak system and a riskier
investment.

In comparison, Jefferson County's bankruptcy plan would
leave it with about $13,626 of debt per customer in the first year of the 40-year
plan.

But that burden would get worse before it would get better.
Under the plan, interest on the county's debt exceeds the payments it would
make for 20 years, causing the debt burden to grow. By the fifth year of the
plan, the county would have $14,798 of debt per customer, more than six times
what Fitch says qualifies a system as financially weak.

Customer cutoffs

Jefferson County's lead bankruptcy lawyer, Kenneth Klee, has
said that the county anticipates modest growth in sewer consumption.

The county's plan proposes sewer rate increases of 7.89 percent
per year for years two through four and 3.49 percent every year after that for
the life of the debt.

However, the revenue projections the county has filed with
the bankruptcy court, predict revenue will not rise as much as the rates. For
instance, as rates rise 3.49 percent in one year, the county projects revenue
will rise only 3.37 percent.

The only way to account for the difference between those two
numbers is if the county is projecting it will see decreased consumption,
either through loss of sewer customers or increased conservation among the
customers it retains, White said.

The water board's chief financial officer, Michael Johnson,
told board members that the system has suffered already because of increased
sewer rates.

Under state law, the water system handles billing of its
customers on the sewer system, and when those customers fail to pay their sewer
bills, the water board cuts off their service.

Since Jefferson County sewer rates began to rise in 2003,
cutoffs among sewer customers have been disproportionate to the number of water
customers on the system, Johnson said.

While sewer customers make up about 59 percent of the water
board's total customers, since 2003 those customers have made up between 74
percent and 88 percent of cutoffs.

Johnson said that since sewer rates have risen, customers
have been irate.

"The reason they are complaining is about that sewer bill,"
Johnson said.

When employees have had to cutoff service to customers,
those customers have sometimes been hostile, Johnson said. A few have been
bitten by dogs, and early this year one customer pulled a weapon, he told the
board.

Board attorney Charlie Waldrep said it is unclear whether
there is anything else the board can do to assert itself into the county's
bankruptcy proceedings.

Commission President David Carrington said that the county's
debt service schedule looks the way it does because, unlike other sewer
systems, the county might not be able to go back to the credit markets for a
very long time. Projecting capital and operating costs 40 years and funding
those through a 40-year debt deal are a peculiar product of the bankruptcy.

"I know of no other sewer system that has tried to put on
paper operating and capital requirements for 40 years," Carrington said. "If they
were asked to do so, their debt structure and corresponding sewer rates would
have to stair-step up through that time period."

As for Fitch's report, he said the ratings agencies will
have their say about Jefferson County before the bankruptcy is over.

"The rating agencies are going to review the proposed debt
structure and issue a report," he said. "Then it will be up to the individual
investors to decide whether it will be a good investment or not."